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all right let's uh let's start um so

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today I want to talk about uh interest

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rates uh you know if you have followed

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the news there's a lot of debate on

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these days on on on where will the

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interest rate in the US end at the end

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of this Titan tiing tightening

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cycle

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uh and um so I'll show you there has

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been a very aggressive monetary policy

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trying to fight the inflationary episode

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we're going through uh and that's done

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through interest rates and and the

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question that I want to address today is

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H well how is it that the interest rate

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is determined so when a central bank

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decides to hike interest rates how do

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they do that okay and obviously this is

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about financial markets interest rate

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are set in financial markets and

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financial markets are very very

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complicated so we're going to keep it

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very very simple we're want to make

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introduce more complexity later on in

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the course but still we're going to keep

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it pretty simple because our main

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objective in studying Financial Market

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is really a a to to re to achieve some

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sort of understanding of how the

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interest rate policy that the Central

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Bank H controls is is

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determined so before

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[Music]

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I I get into specifics so let's let's

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see some trivia here who knows who that

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person is

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okay you

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Geron Powell exactly and who's Jeron

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Powell the chair of the Federal Reserve

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uh system in the US which is the Central

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Bank of the US okay so that's that was

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an easy one and and every you know if

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you are into financial markets everyone

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is worried about what this guy is

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thinking and his friends are thinking at

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this moment because they determine the

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interest rate how do they do that well

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that's what we're going to talk about

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later on a little speaker who is

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this no no that's that's

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cheating katsu WEA he is the next ER

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president of the bank of Japan the

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Central Bank of Japan and an interesting

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there are many interesting things of him

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but about him but he's a he's a graduate

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from our program the PHD

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program which actually is an incredibly

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successful program at producing major

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Central Bankers Ben Bernan is our Alum

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Alum that he was

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the the chairman of the Central Bank the

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chair of the Central Bank of the FED

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during the financial crisis Mario dragi

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is a one of our graduates Mario dragi

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was the the most successful ER Central

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Banker in Europe he was the president of

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the ECB European Central Bank for many

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years and in particular during the

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Global Financial crisis and the European

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crisis which followed the global

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financial

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crisis uh I mean but you name it Stan

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Fisher in the past of the Bank of Israel

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and nowadays feel low of the the chair

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of the Reserve Bank of Australia in

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Chile we have had two or three er

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presents and so on so if you if this is

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your career this is a good program you

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should join our program you may end up

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in a in a good place but that's the the

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next one for Japan

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and and Japan is a very interesting

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place from the point of view of monetary

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policy precisely because they they

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haven't had much space to do

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conventional monetary policy so they

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have had to do lots of unconventional

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things from the point of view of what a

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central bank typically does but today

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we're going to study conventional things

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and we'll talk a little bit more about

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unconventional things later in the

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course now some institutional knowledge

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this is the the again in the US the

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Central Bank of the US is called called

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the Federal Reserve System and it's a

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system really H it's a he has a um in um

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the Board of Governors which sits in

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Washington

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DC um and and there are seven Governors

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and the governors are are are nominated

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by the president and and then confirmed

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by by the Senate and the president of

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that board is is H is so the president

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of the FED of the FED will be one of

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those members okay now on in addition to

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that the the US has a Federal Reserve

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Bank system there are seven there are 12

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Regional Banks uh there's one in Boston

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in fact if you look at the skyline near

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the Waterfront there's a building built

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out of recycled aluminum well that's the

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Reserve Bank of Boston and uh and uh and

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of those 12 Regional Banks they

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rotate so so policy the interested is

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set into in a committee which is called

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the fomc Federal Open Market Committee

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um and and the member of that the voting

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members of that committee are the the

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seven Governors plus h four out of the

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12 and they rotate most of them rotate

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the the only one I think does not rotate

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is the is the is the president of the of

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the New York fed because they're so

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important because that's a financial

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heart of the US

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that you certainly want that H ER

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president to be involved in in interest

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rate decisions and it's really the FED

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that is in charge of communication with

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financial Market which is a huge thing

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for the FED okay they are in New York

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and they're crucial for that okay so

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that's that's that's those are the

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people that and in most places around

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the world you're going to have at least

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something equivalent to the the seven

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governors out there okay most places

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obviously the ECB is different because

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it's multiple countries so each country

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sends one member

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no but but but

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otherwise um it tends to be like like

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the US without the the the regional

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Banks so why do we care about monetary

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policy well because I think it's one of

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the main policy tools you have in the

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short run remember in this part of the

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course we're trying to understand output

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in the short ter and one of the main

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policy levels I mean how can you affect

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output is monetary policy which one is

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the other

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one there are two major ones fiscal

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policy exactly and fiscal policy we did

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look at in the previous lecture remember

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we said an expansionary fiscal policies

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an increase in G or a decline in t would

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lead to an expansion in a great demand

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equilibrium output would go out up okay

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so fiscal policy is something you always

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use in in in deep recessions

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uh but monetary policy is much more

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Nimble is I mean it's a it's a bunch of

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people that need to meet and just change

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the interest rate anything that is

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fiscal there are some automatic

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stabilizers by the way so automatically

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fiscal policy becomes more expansionary

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during recessions and stuff like that

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but any deviation from the typical

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automatic stabilizers require Congress

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to approve things it's a long process

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and so it's not something that can react

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as quickly as monetary policy can okay

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um so that's what we're going to look

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that's that's that's that's the reason

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why monetary policy is important for us

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at this point then there are medium and

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long run issues fiscal policies still

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affects equilibrium output in the medium

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and long run monetary policies much less

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effective at that it's very difficult to

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to change sort of equilibrium growth or

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things like that with monetary policy

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it's going to be pretty minor most of

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the impact of monetary policy in the

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minum and long run is really on the

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price level and inflation more than on

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real activity okay but in the short run

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it's very powerful for reasons that

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we're going to discuss in this and the

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next

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lecture okay so as I said well monetary

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policy acts through financial markets I

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I think it's a very

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interesting part of my research agenda

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is about that is I think is the central

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bank is a very strange institution

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because most of its mandate are in terms

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of what happens in the Goods Market says

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you know you don't try not to get into

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recession try to get us out of a

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recession and so on but unlike fiscal

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policy which has tools that are directly

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aim at the Goods Market remember it's a

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it's a purchases by the government of

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goods so if there isn't sufficient

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demand for goods the fiscal policy the

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fiscal Authority can go out there and

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buy Goods that creates more demand the

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the central bank is given the same

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mandate aside from Price stability and

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things like that we're want to worry

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about later but it doesn't have any

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tools the the the central bank if

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there's insufficient demand the Central

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Bank cannot go out there and buy

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hamburgers right that's fiscal policy

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can do that and expand the demand for

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hamburgers but not monetary policy what

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monetary policy can do is by bonds by

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instruments in the financial markets and

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through that affects real activity so

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the is it's the fastest policy tool but

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it's the most indirect in a sense

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because it it it has to go through

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financial market and and and and that CH

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those channels can be very complex but

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obviously we're not in the business of

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complicating things in this course so

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we're going to make it very very simple

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we're going to assume that financial

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markets only have two instruments

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obviously the huge simplification there

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are millions of financial instruments

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out there but we're going to isolate two

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instruments because this happens to be

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the instrument

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where that that that where the central

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banks typically participate

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they affect all asset prices around but

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the direct interventions typically

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recently has been a little different but

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typically it's only in this kind of

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instruments and so we're going to focus

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all of our analysis on on those two

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instruments for now later on we're going

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to talk about equity and stuff like that

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but but just to isolate the the the how

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monetary policy works is sufficient to

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just focus on two financial instruments

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so we're going to assume that people

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have their wealth in only two forms in

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two Financial assets one we're going to

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call it

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money and the other one we want to call

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it bonds okay

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money the characteristic of money what

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we call money there are many definitions

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of money M1 M2 M3 M4 but let's keep it

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very simple money essentially means

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something that you can use very easily

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for

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transactions okay so for example the the

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most important example of money not the

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largest but the most important one is

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Cash currency okay you can buy anything

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with cash there no problem whatsoever

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now the the the a characteristic that

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money typically does not have is that it

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doesn't give you any

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return you don't invest in cash you know

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you have cash because you need to do

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transactions but it's not the way you

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get a return and so money that's what

277
00:12:00,879 --> 00:12:04,958
it's going to mean for us is something

278
00:12:02,759 --> 00:12:07,240
that is used in transactions but it pays

279
00:12:04,958 --> 00:12:10,599
no interest rate no interest there no

280
00:12:07,240 --> 00:12:12,959
interest on that a bond is going to be

281
00:12:10,600 --> 00:12:14,720
the polar opposite it's going to be

282
00:12:12,958 --> 00:12:18,359
something that pays a positive interest

283
00:12:14,720 --> 00:12:19,759
rate so if you buy a bone for 100 for 95

284
00:12:18,360 --> 00:12:21,919
you're going to get a 100 a year from

285
00:12:19,759 --> 00:12:23,879
now say so you get something out of that

286
00:12:21,919 --> 00:12:26,039
bone but it's not very useful for

287
00:12:23,879 --> 00:12:28,879
transactions I mean you cannot go and

288
00:12:26,039 --> 00:12:30,799
buy your lunch with a bond you get the

289
00:12:28,879 --> 00:12:32,559
piece of B for that and and and many

290
00:12:30,799 --> 00:12:34,919
things cannot be even even within

291
00:12:32,559 --> 00:12:36,679
financial markets you cannot buy asset

292
00:12:34,919 --> 00:12:39,198
with asset you have to go through some

293
00:12:36,679 --> 00:12:41,879
process in which you come sell something

294
00:12:39,198 --> 00:12:43,838
get cash and and with cash you pay for

295
00:12:41,879 --> 00:12:46,879
the other stuff not necessarily cash it

296
00:12:43,839 --> 00:12:48,800
could be other forms of money but but

297
00:12:46,879 --> 00:12:50,679
but typically Financial instrument need

298
00:12:48,799 --> 00:12:53,559
to be sold before you can buy something

299
00:12:50,679 --> 00:12:55,679
else you don't swap them it's not a part

300
00:12:53,559 --> 00:12:59,239
them okay but this is what it means for

301
00:12:55,679 --> 00:13:01,239
us so this whenever you see something

302
00:12:59,240 --> 00:13:04,240
like this is always interesting for an

303
00:13:01,240 --> 00:13:04,240
economist

304
00:13:06,440 --> 00:13:14,160
why and any economies micro economies or

305
00:13:10,360 --> 00:13:16,720
whatever what what have I done

306
00:13:14,159 --> 00:13:18,078
there that makes economics is about

307
00:13:16,720 --> 00:13:22,000
decisions and then it's about

308
00:13:18,078 --> 00:13:22,000
equilibrium okay it's decisions and

309
00:13:22,559 --> 00:13:27,879
equilibrium there's a decision to be

310
00:13:24,559 --> 00:13:29,399
made here there's a tradeoff okay I I

311
00:13:27,879 --> 00:13:31,439
you know if I need to do lots of

312
00:13:29,399 --> 00:13:35,000
transactions I better sort of bias my

313
00:13:31,440 --> 00:13:35,959
portfolio towards cash towards money if

314
00:13:35,000 --> 00:13:38,000
if I don't need to do lots of

315
00:13:35,958 --> 00:13:39,919
transaction then I and the interest rate

316
00:13:38,000 --> 00:13:42,078
is very high particularly then I this is

317
00:13:39,919 --> 00:13:44,360
an issue today today interest rates are

318
00:13:42,078 --> 00:13:47,198
very high nobody care about bonds or

319
00:13:44,360 --> 00:13:49,000
anything you know two years ago when

320
00:13:47,198 --> 00:13:51,120
interest rate was Zero but today

321
00:13:49,000 --> 00:13:52,480
interest rate is 5% so it's an issue

322
00:13:51,120 --> 00:13:54,039
you're not going to if you want to keep

323
00:13:52,480 --> 00:13:56,800
it in cash you're going to give up a lot

324
00:13:54,039 --> 00:13:58,278
of return okay so it's a decision to be

325
00:13:56,799 --> 00:14:00,838
made there a portfolio decision and

326
00:13:58,278 --> 00:14:05,159
that's always interesting for

327
00:14:00,839 --> 00:14:07,839
economies so let's talk about uh that

328
00:14:05,159 --> 00:14:09,360
decision and we're going to talk you can

329
00:14:07,839 --> 00:14:11,120
describe this decision either from the

330
00:14:09,360 --> 00:14:12,320
side of bonds or from the side of money

331
00:14:11,120 --> 00:14:14,240
we're going to describe from the side of

332
00:14:12,320 --> 00:14:16,959
money because there's a total amount of

333
00:14:14,240 --> 00:14:20,159
wealth and you have to decide what to

334
00:14:16,958 --> 00:14:21,599
allocate it to so you know it suffices

335
00:14:20,159 --> 00:14:24,480
if I tell you there a total amount of

336
00:14:21,600 --> 00:14:26,120
wealth and if I tell you how to how much

337
00:14:24,480 --> 00:14:27,240
you allocate to money then I'm telling

338
00:14:26,120 --> 00:14:29,440
you implicitly how much you are

339
00:14:27,240 --> 00:14:31,680
allocating to bonds it's a compliment to

340
00:14:29,440 --> 00:14:33,639
that okay so I can do analysis either

341
00:14:31,679 --> 00:14:36,359
way but I'm going to do it through money

342
00:14:33,639 --> 00:14:38,399
which is the way is normally done so

343
00:14:36,360 --> 00:14:39,720
money demand if I plot it in the space

344
00:14:38,399 --> 00:14:43,399
of

345
00:14:39,720 --> 00:14:45,480
M money and the interest rate is a

346
00:14:43,399 --> 00:14:49,759
downward sloping

347
00:14:45,480 --> 00:14:49,759
curve why is it a downward sloping

348
00:14:51,198 --> 00:14:56,240
curve the interest rate is higher it

349
00:14:54,120 --> 00:14:59,078
pays off more to have B your utility

350
00:14:56,240 --> 00:15:01,399
should exactly your decision if the

351
00:14:59,078 --> 00:15:03,559
interest rate is very high is to go more

352
00:15:01,399 --> 00:15:04,958
towards bone the interest is very low I

353
00:15:03,559 --> 00:15:06,198
don't care too much about bones I'd

354
00:15:04,958 --> 00:15:09,439
rather keep the thing that helps me

355
00:15:06,198 --> 00:15:12,519
transact which is money okay and it's

356
00:15:09,440 --> 00:15:14,839
interesting because for most of your

357
00:15:12,519 --> 00:15:16,078
adult life you have Liv in a world in

358
00:15:14,839 --> 00:15:18,680
which that not was not a very

359
00:15:16,078 --> 00:15:21,078
interesting decision actually no because

360
00:15:18,679 --> 00:15:22,679
interest were very close to zero now

361
00:15:21,078 --> 00:15:25,399
you're living in a different environment

362
00:15:22,679 --> 00:15:28,359
interest Are For the First Time sort of

363
00:15:25,399 --> 00:15:30,720
high for you there may a bigger decision

364
00:15:28,360 --> 00:15:34,159
between invest in equity say and cash

365
00:15:30,720 --> 00:15:36,120
but bonds and and and and these are safe

366
00:15:34,159 --> 00:15:37,719
bonds by the way your treasures and

367
00:15:36,120 --> 00:15:40,198
things like that and money is not

368
00:15:37,720 --> 00:15:43,600
something you have to worry

369
00:15:40,198 --> 00:15:45,198
about okay good what I'm saying is

370
00:15:43,600 --> 00:15:47,399
interest is where around here so you

371
00:15:45,198 --> 00:15:50,399
we're all in cash one way or the other

372
00:15:47,399 --> 00:15:52,198
and now interest are a lot High the

373
00:15:50,399 --> 00:15:53,759
other thing that so that's a movement

374
00:15:52,198 --> 00:15:56,799
along the curve no I'm plotting

375
00:15:53,759 --> 00:15:58,680
something in the space of interest rate

376
00:15:56,799 --> 00:15:59,479
money and interest rate then when I tell

377
00:15:58,679 --> 00:16:01,479
you

378
00:15:59,480 --> 00:16:04,720
what happens when the inter Rises I'm

379
00:16:01,480 --> 00:16:07,480
asking you for a a a movement along the

380
00:16:04,720 --> 00:16:11,240
curve okay I see so if I raise interest

381
00:16:07,480 --> 00:16:12,879
rate I move along the curve up so the

382
00:16:11,240 --> 00:16:14,600
second thing that we have there is

383
00:16:12,879 --> 00:16:16,078
argument we have is something that shift

384
00:16:14,600 --> 00:16:18,319
the curve because it's not part of my

385
00:16:16,078 --> 00:16:20,599
Axis so so it will shift the curve it's

386
00:16:18,318 --> 00:16:24,240
a parameter for each of these curves and

387
00:16:20,600 --> 00:16:26,720
that's nominal income so in particular

388
00:16:24,240 --> 00:16:29,159
if nominal income goes

389
00:16:26,720 --> 00:16:31,278
up I'm showing you there that money

390
00:16:29,159 --> 00:16:32,399
demand goes out meaning for any given

391
00:16:31,278 --> 00:16:33,838
level of interest rate you're going to

392
00:16:32,399 --> 00:16:37,120
demand more

393
00:16:33,839 --> 00:16:38,639
money why do you think that's the case

394
00:16:37,120 --> 00:16:41,198
and again I'm looking here at the

395
00:16:38,639 --> 00:16:43,759
aggregate but but it applies to an

396
00:16:41,198 --> 00:16:43,758
individual as

397
00:16:44,639 --> 00:16:51,680
well so for the same level of wealth now

398
00:16:49,600 --> 00:16:54,319
nominal GDP is

399
00:16:51,679 --> 00:16:58,439
higher remember that nominal GDP is the

400
00:16:54,318 --> 00:17:00,838
same as nominal expenditure here okay so

401
00:16:58,440 --> 00:17:02,120
if GDP is higher then that means there's

402
00:17:00,839 --> 00:17:03,400
going to be more transactions because

403
00:17:02,120 --> 00:17:07,160
there's going to be more

404
00:17:03,399 --> 00:17:09,759
expenditure okay and therefore you need

405
00:17:07,160 --> 00:17:12,480
more of the thing that is use useful for

406
00:17:09,759 --> 00:17:14,640
transactions okay M demand goes up the

407
00:17:12,480 --> 00:17:17,959
second point to highlight is that you

408
00:17:14,640 --> 00:17:20,520
know while in most places I we use why

409
00:17:17,959 --> 00:17:22,240
here I'm using dollar y nominal y why do

410
00:17:20,519 --> 00:17:24,558
you think that's that why why don't I

411
00:17:22,240 --> 00:17:27,959
just put there real GDP rather than

412
00:17:24,558 --> 00:17:27,959
nominal GDP

413
00:17:30,240 --> 00:17:32,679
is the

414
00:17:34,679 --> 00:17:40,679
typo let's go in

415
00:17:37,319 --> 00:17:43,678
steps suppose that prices are totally

416
00:17:40,679 --> 00:17:46,440
fixed and real GDP goes

417
00:17:43,679 --> 00:17:47,720
up that means that this economy needs

418
00:17:46,440 --> 00:17:51,038
more transactions because it's going to

419
00:17:47,720 --> 00:17:53,640
be more expenditure there okay so that

420
00:17:51,038 --> 00:17:56,158
that explains that yeah when real output

421
00:17:53,640 --> 00:17:57,880
goes up then money demand goes up when I

422
00:17:56,159 --> 00:18:00,120
say money demand goes up I said for any

423
00:17:57,880 --> 00:18:04,520
given interest rate we have more money

424
00:18:00,119 --> 00:18:08,239
demand okay now fix real output and I

425
00:18:04,519 --> 00:18:08,240
tell you suppose that the price of goods

426
00:18:08,720 --> 00:18:14,839
doubles do you think you need more money

427
00:18:10,880 --> 00:18:17,120
to transact of course because it's the

428
00:18:14,839 --> 00:18:19,918
same it's equivalent now money is

429
00:18:17,119 --> 00:18:21,599
dollars I have $10 and now prices are

430
00:18:19,919 --> 00:18:24,720
twice what they used to be well I'm

431
00:18:21,599 --> 00:18:26,399
going to need more dollars to transact

432
00:18:24,720 --> 00:18:30,400
okay so that's a reason we have nominal

433
00:18:26,400 --> 00:18:32,159
GDP here rather than real GDP

434
00:18:30,400 --> 00:18:35,640
okay

435
00:18:32,159 --> 00:18:36,600
good so let's now determine the interest

436
00:18:35,640 --> 00:18:39,080
rate and I'm going to do it in the

437
00:18:36,599 --> 00:18:42,359
simplest possible model first and and by

438
00:18:39,079 --> 00:18:44,639
simplest I mean here in particular no

439
00:18:42,359 --> 00:18:49,038
banks no intermediaries okay so there's

440
00:18:44,640 --> 00:18:52,120
only Central Bank and and and and and

441
00:18:49,038 --> 00:18:54,679
people okay so

442
00:18:52,119 --> 00:18:57,119
so suppose that the central banks

443
00:18:54,679 --> 00:18:59,080
decides that wants to this is the way

444
00:18:57,119 --> 00:19:01,319
monetary policy used to be conducted

445
00:18:59,079 --> 00:19:04,879
suppose is the size that it wants to

446
00:19:01,319 --> 00:19:06,439
offer M dollars to the economy and the

447
00:19:04,880 --> 00:19:09,200
central bank is the one that produces

448
00:19:06,440 --> 00:19:13,679
the at this moment which I have no

449
00:19:09,200 --> 00:19:16,279
intermediaries a ER money is really

450
00:19:13,679 --> 00:19:19,880
currency okay the only one that can

451
00:19:16,279 --> 00:19:22,720
produce currency forget Bitcoin only one

452
00:19:19,880 --> 00:19:26,039
that can produce currency is the Central

453
00:19:22,720 --> 00:19:28,839
Bank okay I mean dollars you can no one

454
00:19:26,038 --> 00:19:30,319
else can produce dollars

455
00:19:28,839 --> 00:19:32,038
watch out when we talk about Banks later

456
00:19:30,319 --> 00:19:34,200
on in this economy I'm describing there

457
00:19:32,038 --> 00:19:36,640
are no banks the only one that can

458
00:19:34,200 --> 00:19:38,960
produce Dollars currency is the Central

459
00:19:36,640 --> 00:19:42,000
Bank any other one that produces dollars

460
00:19:38,960 --> 00:19:44,240
that's illegal okay so it's a central

461
00:19:42,000 --> 00:19:45,558
bank so the central bank can decide how

462
00:19:44,240 --> 00:19:48,720
much money to

463
00:19:45,558 --> 00:19:52,158
supply and suppose it decides to supply

464
00:19:48,720 --> 00:19:55,360
M that's it it's a

465
00:19:52,159 --> 00:19:57,600
decision well what is a now for the

466
00:19:55,359 --> 00:19:59,359
first time I can I can answer the

467
00:19:57,599 --> 00:20:02,319
question is well what the interest rate

468
00:19:59,359 --> 00:20:04,599
in this environment why do I know that

469
00:20:02,319 --> 00:20:07,200
because I have a money supply I have a

470
00:20:04,599 --> 00:20:09,319
money demand the intersection at this

471
00:20:07,200 --> 00:20:10,840
level of money supply the equilibrium

472
00:20:09,319 --> 00:20:12,240
interest rate that is interest is

473
00:20:10,839 --> 00:20:15,720
consistent with money demand equal to

474
00:20:12,240 --> 00:20:18,720
money supply is that

475
00:20:15,720 --> 00:20:18,720
one

476
00:20:19,640 --> 00:20:26,440
okay is it clear so I have my money

477
00:20:23,159 --> 00:20:27,880
demand and I'm saying the Central Bank

478
00:20:26,440 --> 00:20:30,080
suppos the Central Bank De size to

479
00:20:27,880 --> 00:20:32,000
supply m well in equilibrium that will

480
00:20:30,079 --> 00:20:34,319
be the interest

481
00:20:32,000 --> 00:20:36,240
rate okay that's the way the interest

482
00:20:34,319 --> 00:20:39,240
rate is

483
00:20:36,240 --> 00:20:39,240
determined

484
00:20:40,240 --> 00:20:45,919
now suppose that the Central Bank

485
00:20:42,839 --> 00:20:48,480
increases remember the the goal of this

486
00:20:45,919 --> 00:20:50,480
lecture is that we get to understand how

487
00:20:48,480 --> 00:20:52,480
is that interest rate is deter is

488
00:20:50,480 --> 00:20:54,400
determined how is that the fed the

489
00:20:52,480 --> 00:20:57,599
Central Bank determines the interest

490
00:20:54,400 --> 00:20:59,519
rate here we said look the Central Bank

491
00:20:57,599 --> 00:21:00,959
decide on certain am amount of money and

492
00:20:59,519 --> 00:21:02,240
then the market determines what the

493
00:21:00,960 --> 00:21:04,880
interest rate

494
00:21:02,240 --> 00:21:07,359
is and this is the way monetary policy

495
00:21:04,880 --> 00:21:09,200
used to be conducted the central banks

496
00:21:07,359 --> 00:21:10,639
would typically decide the amount of

497
00:21:09,200 --> 00:21:13,240
money in the system it was called

498
00:21:10,640 --> 00:21:14,799
monetary Aggregates the amount of money

499
00:21:13,240 --> 00:21:16,359
in the system and then the market would

500
00:21:14,798 --> 00:21:19,519
determine the interest

501
00:21:16,359 --> 00:21:21,879
rate it turned out that that was a

502
00:21:19,519 --> 00:21:24,200
nightmare and so now that's that's not

503
00:21:21,880 --> 00:21:26,919
what central banks do but and it was a

504
00:21:24,200 --> 00:21:29,240
night mayor because this money demand

505
00:21:26,919 --> 00:21:31,200
that looks so peaceful here in practice

506
00:21:29,240 --> 00:21:34,159
is moving around all the time for a

507
00:21:31,200 --> 00:21:36,278
variety of reason you know even holidays

508
00:21:34,159 --> 00:21:38,799
affect the money demand and all that so

509
00:21:36,278 --> 00:21:40,480
so if you fix the monetary Aggregates

510
00:21:38,798 --> 00:21:43,599
and many the man is moving all over the

511
00:21:40,480 --> 00:21:43,599
place what what

512
00:21:44,159 --> 00:21:48,360
happens suppose the Central Bank says

513
00:21:46,519 --> 00:21:50,480
I'm going to offer this amount of M

514
00:21:48,359 --> 00:21:51,719
that's it and now I tell you money the

515
00:21:50,480 --> 00:21:53,000
money is moving all over the place

516
00:21:51,720 --> 00:21:55,960
they're weeks that they have you know

517
00:21:53,000 --> 00:21:58,000
three days of of weekend that have you

518
00:21:55,960 --> 00:22:00,798
know vacations in between or there's a

519
00:21:58,000 --> 00:22:06,000
Super Bowl lots of people decide to buy

520
00:22:00,798 --> 00:22:06,000
tickets or whatever or beer so

521
00:22:06,159 --> 00:22:09,520
whatever well

522
00:22:10,558 --> 00:22:16,839
no because when you say shortage I mean

523
00:22:14,000 --> 00:22:18,240
depends what you mean by shortage but so

524
00:22:16,839 --> 00:22:19,879
so you could be right with that part of

525
00:22:18,240 --> 00:22:22,640
the answer but but when you say exess

526
00:22:19,880 --> 00:22:23,880
theand then I have a problem because

527
00:22:22,640 --> 00:22:25,679
that's true only if the interest rate

528
00:22:23,880 --> 00:22:28,240
doesn't

529
00:22:25,679 --> 00:22:30,159
move but in a in a in a situation you

530
00:22:28,240 --> 00:22:33,919
could just the Central Bank fix M and

531
00:22:30,159 --> 00:22:35,600
let the market do its thing then the

532
00:22:33,919 --> 00:22:37,038
interest rate will not be fixed and

533
00:22:35,599 --> 00:22:39,558
that's exactly the problem that the

534
00:22:37,038 --> 00:22:41,558
interest rate becomes very very volatile

535
00:22:39,558 --> 00:22:44,158
if you if you do it only only through

536
00:22:41,558 --> 00:22:46,759
through monetary arates because this guy

537
00:22:44,159 --> 00:22:47,960
is moving all over the place and so

538
00:22:46,759 --> 00:22:49,919
imagine what happens if this demand

539
00:22:47,960 --> 00:22:52,720
shift up then in equilibrium it say goes

540
00:22:49,919 --> 00:22:55,320
up precisely to avoid your excess demand

541
00:22:52,720 --> 00:22:57,360
no because if this thing goes up I have

542
00:22:55,319 --> 00:22:58,839
an excess demand at that interest rate

543
00:22:57,359 --> 00:23:00,839
but what happen in equili is the

544
00:22:58,839 --> 00:23:04,158
interest rate will go up and so until

545
00:23:00,839 --> 00:23:07,678
the the excess demand

546
00:23:04,159 --> 00:23:10,120
disappears now in in central banks like

547
00:23:07,679 --> 00:23:12,038
the US Central Bank the FED they can

548
00:23:10,119 --> 00:23:13,519
control this stuff fairly well many

549
00:23:12,038 --> 00:23:16,278
other central banks don't have that if

550
00:23:13,519 --> 00:23:18,158
you look at the at the central at at the

551
00:23:16,278 --> 00:23:20,038
Bank of China for example they have lots

552
00:23:18,159 --> 00:23:21,760
of high frequency movements in interest

553
00:23:20,038 --> 00:23:25,200
rate because they not very good at doing

554
00:23:21,759 --> 00:23:27,400
this stuff it's it's not that easy to

555
00:23:25,200 --> 00:23:29,880
okay to to to control an interest rate

556
00:23:27,400 --> 00:23:32,240
for example to keep it we but the

557
00:23:29,880 --> 00:23:34,480
Central Bank used to do that that's what

558
00:23:32,240 --> 00:23:36,640
I'm saying used to do that I'm saying in

559
00:23:34,480 --> 00:23:38,440
practice this system wasn't very good

560
00:23:36,640 --> 00:23:40,799
because this in practice this the man is

561
00:23:38,440 --> 00:23:42,880
moving around for a lot of EOS syncratic

562
00:23:40,798 --> 00:23:44,400
reasons okay some of them are EOS

563
00:23:42,880 --> 00:23:46,559
syncratic some of them are very

564
00:23:44,400 --> 00:23:50,320
predictable there was a lot of panic

565
00:23:46,558 --> 00:23:52,240
around the shift of the year 2000 that

566
00:23:50,319 --> 00:23:54,599
the ATMs would stop working and stuff

567
00:23:52,240 --> 00:23:56,240
like that so it was a massive increase

568
00:23:54,599 --> 00:23:59,278
in money demand because people wanted to

569
00:23:56,240 --> 00:24:01,720
have cash just in case ATMs sto working

570
00:23:59,278 --> 00:24:03,319
okay and and so there are some are

571
00:24:01,720 --> 00:24:05,960
predictable and so but but you can get

572
00:24:03,319 --> 00:24:09,158
very large fluctuations so in practice

573
00:24:05,960 --> 00:24:10,640
what central banks do nowadays is really

574
00:24:09,159 --> 00:24:13,400
is they tell you what the interest rate

575
00:24:10,640 --> 00:24:15,320
is and then they offer whatever M the

576
00:24:13,400 --> 00:24:17,278
market needs for that interest rate

577
00:24:15,319 --> 00:24:19,200
that's the way modern monetary policy

578
00:24:17,278 --> 00:24:21,440
works okay I I'll tell you a little bit

579
00:24:19,200 --> 00:24:25,399
more about that so let's see what

580
00:24:21,440 --> 00:24:29,640
happens here if if if if

581
00:24:25,398 --> 00:24:30,798
uh if the suppose the the Fed

582
00:24:29,640 --> 00:24:32,799
for reasons that you'll understand

583
00:24:30,798 --> 00:24:34,359
better in the SEC in the next lecture

584
00:24:32,798 --> 00:24:37,278
suppose the FED decides that they want

585
00:24:34,359 --> 00:24:40,519
to have an expansionary monetary policy

586
00:24:37,278 --> 00:24:42,480
expansion in monetary policy means it's

587
00:24:40,519 --> 00:24:45,679
going to spand M it was offering certain

588
00:24:42,480 --> 00:24:49,360
amount of M and now it decides to offer

589
00:24:45,679 --> 00:24:51,519
more of the D so what happens in

590
00:24:49,359 --> 00:24:54,038
equilibrium well we start from an

591
00:24:51,519 --> 00:24:55,720
equilibrium here if the interest rate

592
00:24:54,038 --> 00:24:56,759
remains at that level now we have an

593
00:24:55,720 --> 00:24:59,399
excess

594
00:24:56,759 --> 00:25:01,679
supply of money

595
00:24:59,398 --> 00:25:04,959
okay and the only way to restore that

596
00:25:01,679 --> 00:25:07,919
equilibrium is by people demanding more

597
00:25:04,960 --> 00:25:10,558
money and how when will people demand

598
00:25:07,919 --> 00:25:11,200
more money well when the interest rate

599
00:25:10,558 --> 00:25:14,639
is

600
00:25:11,200 --> 00:25:17,000
lower okay so excess demand the interest

601
00:25:14,640 --> 00:25:18,520
start declining then demand for money

602
00:25:17,000 --> 00:25:21,720
starts catching up with a new higher

603
00:25:18,519 --> 00:25:23,038
supply of money okay and you end up with

604
00:25:21,720 --> 00:25:25,558
a lower interest

605
00:25:23,038 --> 00:25:27,759
rate okay so that's an expansion in

606
00:25:25,558 --> 00:25:30,480
monetary policy an increasing M that

607
00:25:27,759 --> 00:25:32,798
leads to a decline in the interest rate

608
00:25:30,480 --> 00:25:35,839
again mod than central banks don't tell

609
00:25:32,798 --> 00:25:37,519
you we're going to increase M by 20%

610
00:25:35,839 --> 00:25:41,359
what they tell you is we're going to cut

611
00:25:37,519 --> 00:25:43,599
interest rate by say 50 basis

612
00:25:41,359 --> 00:25:45,959
points when they tell you that they're

613
00:25:43,599 --> 00:25:47,398
going to C cut interest in by 50 point

614
00:25:45,960 --> 00:25:51,038
they're reading you this

615
00:25:47,398 --> 00:25:53,918
accxes but

616
00:25:51,038 --> 00:25:55,319
behind that operation there must have

617
00:25:53,919 --> 00:25:57,600
been an increase in money

618
00:25:55,319 --> 00:26:00,278
supply and then it comes all the fine

619
00:25:57,599 --> 00:26:02,000
tuning that that they have to do know so

620
00:26:00,278 --> 00:26:03,919
so the interestate remains there when

621
00:26:02,000 --> 00:26:05,919
the man is vibrating around that thing

622
00:26:03,919 --> 00:26:07,679
there but the when we say an

623
00:26:05,919 --> 00:26:11,120
expansionary monetary policy we really

624
00:26:07,679 --> 00:26:13,640
mean cutting interest rates how is the

625
00:26:11,119 --> 00:26:15,959
interest rates cut effectively by

626
00:26:13,640 --> 00:26:17,480
increasing the money supply but they

627
00:26:15,960 --> 00:26:20,880
don't tell you that they are doing that

628
00:26:17,480 --> 00:26:20,880
but that's what they're doing

629
00:26:22,519 --> 00:26:28,079
okay good so nowadays we're in the

630
00:26:26,200 --> 00:26:29,960
opposite process we're moving that way

631
00:26:28,079 --> 00:26:34,038
no

632
00:26:29,960 --> 00:26:35,759
up but you seen in every single meeting

633
00:26:34,038 --> 00:26:39,440
now for the last seven minutes or so we

634
00:26:35,759 --> 00:26:42,000
have seen a hike in interest ratees okay

635
00:26:39,440 --> 00:26:43,120
H well that's they don't tell you that

636
00:26:42,000 --> 00:26:45,919
but they're saying we're going to cut

637
00:26:43,119 --> 00:26:47,879
money supply and moving in that

638
00:26:45,919 --> 00:26:49,799
direction that

639
00:26:47,880 --> 00:26:52,640
direction because if they move in that

640
00:26:49,798 --> 00:26:54,879
direction then interest rate go

641
00:26:52,640 --> 00:26:58,880
up

642
00:26:54,880 --> 00:26:58,880
clear good

643
00:26:59,839 --> 00:27:06,558
what else shifts uh this is different

644
00:27:04,278 --> 00:27:08,720
kind of shift suppose that nominal

645
00:27:06,558 --> 00:27:10,558
income goes up and this is happening all

646
00:27:08,720 --> 00:27:12,200
the time nominal income is growing in

647
00:27:10,558 --> 00:27:14,200
most economies most of the time unless

648
00:27:12,200 --> 00:27:15,840
you're in a recession nominal income is

649
00:27:14,200 --> 00:27:17,080
growing it's growing for two reasons one

650
00:27:15,839 --> 00:27:19,599
because we have inflation and the other

651
00:27:17,079 --> 00:27:22,960
one is because real output is growing

652
00:27:19,599 --> 00:27:25,439
that means that that typically in an

653
00:27:22,960 --> 00:27:26,880
average year manyy demand is Shifting to

654
00:27:25,440 --> 00:27:28,759
the

655
00:27:26,880 --> 00:27:31,278
right okay

656
00:27:28,759 --> 00:27:33,119
so if money demand shift to the right

657
00:27:31,278 --> 00:27:37,200
and money supply does not

658
00:27:33,119 --> 00:27:37,199
change then what happens to the interest

659
00:27:38,398 --> 00:27:43,439
rate money demand goes up money supplies

660
00:27:41,960 --> 00:27:45,000
doesn't change what happens to the

661
00:27:43,440 --> 00:27:48,320
interest

662
00:27:45,000 --> 00:27:51,599
rate increases because at this interest

663
00:27:48,319 --> 00:27:54,798
rate here we have an excess demand for

664
00:27:51,599 --> 00:27:56,678
money so we have to reduce the money

665
00:27:54,798 --> 00:27:58,960
demand how do we reduce money Demand by

666
00:27:56,679 --> 00:28:01,919
increasing the interest rate

667
00:27:58,960 --> 00:28:04,480
that's way we so that's yet another

668
00:28:01,919 --> 00:28:07,559
reason why why it's not a good idea to

669
00:28:04,480 --> 00:28:09,319
be targeting monetary Aggregates the FED

670
00:28:07,558 --> 00:28:12,879
tells you we we want the interest rate

671
00:28:09,319 --> 00:28:14,639
at 5% say okay and then the economy will

672
00:28:12,880 --> 00:28:16,000
be growing and so on and what the FED

673
00:28:14,640 --> 00:28:17,960
will be doing is if they want to

674
00:28:16,000 --> 00:28:19,759
maintain the interest rate at 5% well

675
00:28:17,960 --> 00:28:22,840
they'll keep expanding M so the interest

676
00:28:19,759 --> 00:28:25,480
rate doesn't go up okay that's the way

677
00:28:22,839 --> 00:28:27,678
normally conduct but if the if the FED

678
00:28:25,480 --> 00:28:30,319
stays sleepy and and and you have an

679
00:28:27,679 --> 00:28:33,360
increasing many demand then then the

680
00:28:30,319 --> 00:28:33,359
interest will tend to go

681
00:28:35,480 --> 00:28:44,159
up so I told you that that

682
00:28:40,200 --> 00:28:45,759
ER that the central bank is moving M

683
00:28:44,159 --> 00:28:47,919
increasing them reducing them or

684
00:28:45,759 --> 00:28:50,000
whatever so how do they do

685
00:28:47,919 --> 00:28:52,880
that I

686
00:28:50,000 --> 00:28:55,000
mean it's not that they although that

687
00:28:52,880 --> 00:28:57,278
police has been advocated it's not that

688
00:28:55,000 --> 00:28:59,720
they go in a helicopter and sort of fly

689
00:28:57,278 --> 00:29:02,038
bills on top of all of us they don't do

690
00:28:59,720 --> 00:29:03,960
that although again it has been

691
00:29:02,038 --> 00:29:06,119
advocated in extreme cases of recessions

692
00:29:03,960 --> 00:29:10,319
and so on and it's called helicopter

693
00:29:06,119 --> 00:29:12,639
money just give money away okay

694
00:29:10,319 --> 00:29:14,639
ER but that's not the way it's normally

695
00:29:12,640 --> 00:29:17,600
done for normal operations is not done

696
00:29:14,640 --> 00:29:19,200
that way so how is it done remember that

697
00:29:17,599 --> 00:29:22,879
we have a financial system that is very

698
00:29:19,200 --> 00:29:25,399
simple for now we have money and bonds

699
00:29:22,880 --> 00:29:26,480
so what the Central Bank does the

700
00:29:25,398 --> 00:29:27,639
Central Bank wants to change the

701
00:29:26,480 --> 00:29:29,839
portfolio of people that they want

702
00:29:27,640 --> 00:29:31,759
people to have less bonds say and more

703
00:29:29,839 --> 00:29:33,599
money that's when that's to ruce the

704
00:29:31,759 --> 00:29:36,079
interest rate so what the Central Bank

705
00:29:33,599 --> 00:29:38,158
does is goes up there and expansionary

706
00:29:36,079 --> 00:29:40,119
open market operation open market is

707
00:29:38,159 --> 00:29:44,640
because they go into the open market to

708
00:29:40,119 --> 00:29:46,839
buy bonds okay they as as opposed to an

709
00:29:44,640 --> 00:29:48,240
operation that happens behind doors if

710
00:29:46,839 --> 00:29:50,038
the if the FED went directly to the

711
00:29:48,240 --> 00:29:52,519
treasury and bought bonds that would not

712
00:29:50,038 --> 00:29:54,119
be an open market operation okay but

713
00:29:52,519 --> 00:29:56,599
what they do is they go to financial

714
00:29:54,119 --> 00:30:00,639
their financial system and they go with

715
00:29:56,599 --> 00:30:04,199
a big bag of money and say okay we want

716
00:30:00,640 --> 00:30:08,000
bones and so the public sells bones to

717
00:30:04,200 --> 00:30:10,480
them in exchange for money okay that's

718
00:30:08,000 --> 00:30:13,359
an expansion in market so what we saw

719
00:30:10,480 --> 00:30:15,839
that before when M shift to the right

720
00:30:13,359 --> 00:30:18,240
what the central bank really did is went

721
00:30:15,839 --> 00:30:20,599
out there and bought bonds from the

722
00:30:18,240 --> 00:30:24,200
public the public sold the

723
00:30:20,599 --> 00:30:26,439
bonds and got the cash okay at some

724
00:30:24,200 --> 00:30:27,720
price people when when I show you

725
00:30:26,440 --> 00:30:29,080
equilibrium in the money market that

726
00:30:27,720 --> 00:30:32,120
means also an equilibrium in the bond

727
00:30:29,079 --> 00:30:34,639
market necessarily so it has to be that

728
00:30:32,119 --> 00:30:36,558
the price is right for the for the

729
00:30:34,640 --> 00:30:38,320
portfolio of individuals a

730
00:30:36,558 --> 00:30:40,240
contractionary open market operation is

731
00:30:38,319 --> 00:30:43,319
the opposite is a central bank goes out

732
00:30:40,240 --> 00:30:45,798
there and sells bonds to the market and

733
00:30:43,319 --> 00:30:47,720
takes the cash back okay that's a

734
00:30:45,798 --> 00:30:49,918
contractionary monetary policy so when

735
00:30:47,720 --> 00:30:52,120
the FED wants to yeah when the FED let

736
00:30:49,919 --> 00:30:54,759
me justew when the FED wants to cut

737
00:30:52,119 --> 00:30:57,119
interest rate what the FED does is an

738
00:30:54,759 --> 00:30:59,000
expansion in monetary policy which means

739
00:30:57,119 --> 00:31:01,798
it goes out there and buys bonds from

740
00:30:59,000 --> 00:31:04,159
the market and gives cash to the market

741
00:31:01,798 --> 00:31:06,038
yeah can how can the Central Banking

742
00:31:04,159 --> 00:31:08,399
assistance guarantee that some's apply

743
00:31:06,038 --> 00:31:09,798
their bonds like if they didn't have if

744
00:31:08,398 --> 00:31:12,079
their government didn't have the

745
00:31:09,798 --> 00:31:13,759
financial stability I guess the like

746
00:31:12,079 --> 00:31:16,199
United States has how would they

747
00:31:13,759 --> 00:31:18,158
guarantee that these bonds will be worth

748
00:31:16,200 --> 00:31:20,000
anything in the long well I mean there's

749
00:31:18,159 --> 00:31:21,480
you're talking about risk premium and

750
00:31:20,000 --> 00:31:25,000
that's a that's

751
00:31:21,480 --> 00:31:28,480
that's that's an an additional issue

752
00:31:25,000 --> 00:31:31,480
typically a a central banks inter

753
00:31:28,480 --> 00:31:34,159
in in in in very short duration bonds so

754
00:31:31,480 --> 00:31:36,639
there it's not the typical bond that is

755
00:31:34,159 --> 00:31:39,440
risky in many sense it's very very very

756
00:31:36,638 --> 00:31:42,519
short duration bonds treasuries very

757
00:31:39,440 --> 00:31:44,240
short duration in fact it's even less

758
00:31:42,519 --> 00:31:48,440
nowadays central banks really intervene

759
00:31:44,240 --> 00:31:50,319
in the in the overnight Market is is but

760
00:31:48,440 --> 00:31:52,278
but you're right that that countries

761
00:31:50,319 --> 00:31:54,678
that don't have a bond market a

762
00:31:52,278 --> 00:31:56,200
well-developed market have problems with

763
00:31:54,679 --> 00:31:57,360
the management of monetary policy and so

764
00:31:56,200 --> 00:31:59,240
on because they have a cretive spread

765
00:31:57,359 --> 00:32:00,599
that is moving around around as well but

766
00:31:59,240 --> 00:32:02,399
they tend to focus on the type of

767
00:32:00,599 --> 00:32:05,558
instruments that thing becomes very

768
00:32:02,398 --> 00:32:07,879
important I mean for Japan even big guys

769
00:32:05,558 --> 00:32:10,558
very big guys now they have an issue

770
00:32:07,880 --> 00:32:13,200
because they have been buying bonds very

771
00:32:10,558 --> 00:32:16,119
long duration bonds 10 year bonds and

772
00:32:13,200 --> 00:32:17,919
stuff like that and there it's a little

773
00:32:16,119 --> 00:32:19,719
trickier Market need to trust you a lot

774
00:32:17,919 --> 00:32:21,440
more if you're dealing with 10e things

775
00:32:19,720 --> 00:32:23,600
and you're dealing with a three-month

776
00:32:21,440 --> 00:32:28,840
Horizons and so

777
00:32:23,599 --> 00:32:31,398
on in other instances a um

778
00:32:28,839 --> 00:32:33,638
erh for example Chile has a situation

779
00:32:31,398 --> 00:32:36,599
like that the Central Bank itself can

780
00:32:33,638 --> 00:32:38,638
issue bonds and so those are bonds

781
00:32:36,599 --> 00:32:40,879
issued by the central banks and they

782
00:32:38,638 --> 00:32:42,158
tend to be very reliable bonds because

783
00:32:40,880 --> 00:32:43,880
these are bonds that are issuing your

784
00:32:42,159 --> 00:32:45,399
same currency so you have the currency

785
00:32:43,880 --> 00:32:48,120
to always pay the you can always print

786
00:32:45,398 --> 00:32:50,079
money and pay for those bonds you see so

787
00:32:48,119 --> 00:32:53,158
it rarely happens that there is default

788
00:32:50,079 --> 00:32:56,278
on bonds of that kind

789
00:32:53,159 --> 00:33:00,000
ER the typical bonds government bond

790
00:32:56,278 --> 00:33:01,440
that defaults is a bond that is issuing

791
00:33:00,000 --> 00:33:03,079
a currency different from the one you

792
00:33:01,440 --> 00:33:04,919
have because then you may not have the

793
00:33:03,079 --> 00:33:07,398
currency to pay for stu okay and that's

794
00:33:04,919 --> 00:33:09,799
the reason em markets run into trouble

795
00:33:07,398 --> 00:33:12,439
and things of that kind

796
00:33:09,798 --> 00:33:14,319
okay so in terms of the balance sheet of

797
00:33:12,440 --> 00:33:17,080
the Central Bank how does an open market

798
00:33:14,319 --> 00:33:18,519
operation look so if you look at the at

799
00:33:17,079 --> 00:33:20,199
the balance sheet this is an incredibly

800
00:33:18,519 --> 00:33:23,000
simplified version of the balance sheet

801
00:33:20,200 --> 00:33:25,440
of the of the FED no they have lots of

802
00:33:23,000 --> 00:33:28,798
things some more assets gold and all

803
00:33:25,440 --> 00:33:32,038
sort of stuff but in our simple economy

804
00:33:28,798 --> 00:33:34,079
the government the the fed the assets of

805
00:33:32,038 --> 00:33:36,278
the feds is they have some bonds it has

806
00:33:34,079 --> 00:33:38,519
already some bonds out there and the

807
00:33:36,278 --> 00:33:40,278
liabilities is the money they issue they

808
00:33:38,519 --> 00:33:42,480
owe that to people I mean they issue

809
00:33:40,278 --> 00:33:43,798
currency but you know but but that's

810
00:33:42,480 --> 00:33:46,159
it's a

811
00:33:43,798 --> 00:33:47,720
liability people can do things with can

812
00:33:46,159 --> 00:33:49,840
buy things with that money and so it's a

813
00:33:47,720 --> 00:33:52,919
liability so that's the way the balance

814
00:33:49,839 --> 00:33:55,638
sheet looks so when when the the FED

815
00:33:52,919 --> 00:33:59,679
decides to do an expansionary open

816
00:33:55,638 --> 00:34:03,398
market operation then what it does is it

817
00:33:59,679 --> 00:34:06,240
goes out there it IT issues an say a $1

818
00:34:03,398 --> 00:34:08,000
million expansionary open market

819
00:34:06,240 --> 00:34:10,480
operation they do it in much we get

820
00:34:08,000 --> 00:34:13,239
tickets on this but let's make it simple

821
00:34:10,480 --> 00:34:15,719
$1 million of an expansionary operation

822
00:34:13,239 --> 00:34:18,638
but they go they go out there they they

823
00:34:15,719 --> 00:34:22,078
print a million dollars and they buy a

824
00:34:18,639 --> 00:34:25,960
million dollars from the market okay and

825
00:34:22,079 --> 00:34:28,240
so at the end the balance sheet ends

826
00:34:25,960 --> 00:34:30,800
like it used to be the there's an extra

827
00:34:28,239 --> 00:34:32,719
$1 million of liabilities because now

828
00:34:30,800 --> 00:34:36,079
there's a million more of dollars

829
00:34:32,719 --> 00:34:38,039
circulating out there and but but the

830
00:34:36,079 --> 00:34:42,079
against that the Central Bank also has a

831
00:34:38,039 --> 00:34:44,878
million more of bonds Holdings

832
00:34:42,079 --> 00:34:47,320
okay so that's that's what happens with

833
00:34:44,878 --> 00:34:49,199
when so so when in an expansionary

834
00:34:47,320 --> 00:34:51,559
monetary policy the balance sheet of the

835
00:34:49,199 --> 00:34:55,239
Central Bank expands both sides expand

836
00:34:51,559 --> 00:34:58,559
by the same amount okay but expands and

837
00:34:55,239 --> 00:34:59,919
one of the big themes of recent years

838
00:34:58,559 --> 00:35:02,719
starting from the global financial

839
00:34:59,920 --> 00:35:05,320
crisis is that these balance sheets used

840
00:35:02,719 --> 00:35:07,000
to be small peanuts type things for I

841
00:35:05,320 --> 00:35:09,720
mean a trillion dollar or something like

842
00:35:07,000 --> 00:35:12,480
that for something like the the US the

843
00:35:09,719 --> 00:35:14,159
size nowadays they're much much larger

844
00:35:12,480 --> 00:35:15,719
than that because they have done so many

845
00:35:14,159 --> 00:35:17,279
operations to first get us out of the

846
00:35:15,719 --> 00:35:19,279
global financial crisis and then to get

847
00:35:17,280 --> 00:35:20,800
us out of covid and so on that these

848
00:35:19,280 --> 00:35:23,440
balance sheets are

849
00:35:20,800 --> 00:35:25,599
now an order or two orders of magnitude

850
00:35:23,440 --> 00:35:28,920
larger than they used to be

851
00:35:25,599 --> 00:35:31,440
okay but be in words they have had to do

852
00:35:28,920 --> 00:35:35,559
lots of expansionary monetary policy

853
00:35:31,440 --> 00:35:35,559
over the last couple of decades or

854
00:35:37,440 --> 00:35:43,920
so so let me talk about a little bit

855
00:35:40,838 --> 00:35:46,000
about interest rate and bond prices

856
00:35:43,920 --> 00:35:49,519
because that's the other side of this

857
00:35:46,000 --> 00:35:50,838
thing so so what is the connection

858
00:35:49,519 --> 00:35:52,199
because sometimes it's easier to

859
00:35:50,838 --> 00:35:56,440
understand things in terms of price in

860
00:35:52,199 --> 00:35:58,838
terms of bonds so suppose a bond pays

861
00:35:56,440 --> 00:36:00,920
$100 a year from now and and no coupon

862
00:35:58,838 --> 00:36:05,000
in between so if you buy a bond now for

863
00:36:00,920 --> 00:36:07,680
some price PB you get $100 a year from

864
00:36:05,000 --> 00:36:09,920
now so what is the interest rate of that

865
00:36:07,679 --> 00:36:11,480
bond that is what is the excess return

866
00:36:09,920 --> 00:36:13,358
that you get out of that or the return

867
00:36:11,480 --> 00:36:17,000
you get out of buying that

868
00:36:13,358 --> 00:36:20,159
Bond well it's going to be $100 minus

869
00:36:17,000 --> 00:36:23,679
whatever you pay today say you pay 95

870
00:36:20,159 --> 00:36:26,598
then $5 divided by your investment

871
00:36:23,679 --> 00:36:29,279
initial investment which was 95 okay so

872
00:36:26,599 --> 00:36:32,760
that's a bond that gives you know a

873
00:36:29,280 --> 00:36:34,000
little bit more than 5% in a year okay

874
00:36:32,760 --> 00:36:35,960
that's a return that's interesting so

875
00:36:34,000 --> 00:36:38,838
that's a connection between interest

876
00:36:35,960 --> 00:36:40,000
rate and prices and notice that this is

877
00:36:38,838 --> 00:36:43,279
an inverse

878
00:36:40,000 --> 00:36:46,159
relation you know when the price of a

879
00:36:43,280 --> 00:36:47,640
bond goes up the interest rate pay goes

880
00:36:46,159 --> 00:36:49,399
down because you're paying more for the

881
00:36:47,639 --> 00:36:51,559
same principle you're going to get 100

882
00:36:49,400 --> 00:36:52,760
but now you're paying more for it well

883
00:36:51,559 --> 00:36:56,039
that means the interest rate the return

884
00:36:52,760 --> 00:36:58,319
on that Bond went down

885
00:36:56,039 --> 00:37:00,000
okay conversion you can say the other

886
00:36:58,318 --> 00:37:01,759
way around the higher is the interest

887
00:37:00,000 --> 00:37:04,119
rate the lower is the price of bond of a

888
00:37:01,760 --> 00:37:05,680
bond so for example today the interest

889
00:37:04,119 --> 00:37:09,760
rate is

890
00:37:05,679 --> 00:37:11,639
5% a ER if I want to issue a bond that

891
00:37:09,760 --> 00:37:15,040
doesn't pay any coupon and I'm

892
00:37:11,639 --> 00:37:16,358
completely safe so I'm the US Treasury

893
00:37:15,039 --> 00:37:18,159
I'm going to be able to sell that bone

894
00:37:16,358 --> 00:37:20,559
for

895
00:37:18,159 --> 00:37:21,598
95 two years ago when the interest rate

896
00:37:20,559 --> 00:37:23,639
was

897
00:37:21,599 --> 00:37:26,160
Zero the fair would have been able to

898
00:37:23,639 --> 00:37:28,078
sell that bond for

899
00:37:26,159 --> 00:37:29,440
100 okay

900
00:37:28,079 --> 00:37:30,880
so there's an inverse relationship

901
00:37:29,440 --> 00:37:34,200
between the interest rate and the price

902
00:37:30,880 --> 00:37:36,720
of bonds and now I can take you back to

903
00:37:34,199 --> 00:37:38,039
my open market operation so remember

904
00:37:36,719 --> 00:37:40,480
what what I said there's another way of

905
00:37:38,039 --> 00:37:42,838
remembering sort of which way these

906
00:37:40,480 --> 00:37:44,760
signs go remember when you have an

907
00:37:42,838 --> 00:37:46,318
expansionary monetary operation I said

908
00:37:44,760 --> 00:37:49,680
the FED goes out there with a back of

909
00:37:46,318 --> 00:37:52,119
money and buys bonds from the market

910
00:37:49,679 --> 00:37:53,719
when bonds when you buy something when

911
00:37:52,119 --> 00:37:55,000
there's an enormous increase in demand

912
00:37:53,719 --> 00:37:58,078
for something what do you think happens

913
00:37:55,000 --> 00:38:00,880
to the price of that something

914
00:37:58,079 --> 00:38:03,680
goes up no for anything cars whatever it

915
00:38:00,880 --> 00:38:07,039
is if there's a lot more demand then

916
00:38:03,679 --> 00:38:10,919
prices will go up and the FED has a lot

917
00:38:07,039 --> 00:38:13,199
of cash so he can really buy large

918
00:38:10,920 --> 00:38:15,760
amount of bonds and so when the FED goes

919
00:38:13,199 --> 00:38:17,639
out there and does an expansionary open

920
00:38:15,760 --> 00:38:19,880
market operation means it goes out there

921
00:38:17,639 --> 00:38:21,879
and buys a lot of bonds the price of

922
00:38:19,880 --> 00:38:23,400
those bonds goes up and made that

923
00:38:21,880 --> 00:38:25,960
formula that means the interest rate is

924
00:38:23,400 --> 00:38:27,960
going down okay so that's another way of

925
00:38:25,960 --> 00:38:30,720
understanding how is it

926
00:38:27,960 --> 00:38:32,318
expansion open market operation lowers

927
00:38:30,719 --> 00:38:34,639
the interest rate it's because it raises

928
00:38:32,318 --> 00:38:36,639
the price of the bonds that is

929
00:38:34,639 --> 00:38:40,239
demanding and when you raise the price

930
00:38:36,639 --> 00:38:40,239
of the bonds then the interest rate goes

931
00:38:43,800 --> 00:38:51,800
down will I do this to

932
00:38:47,039 --> 00:38:53,519
you well very quickly so really the only

933
00:38:51,800 --> 00:38:55,760
thing I really care I want you to

934
00:38:53,519 --> 00:38:58,000
understand what I what I just said well

935
00:38:55,760 --> 00:39:00,480
because we're going to use it

936
00:38:58,000 --> 00:39:03,440
I want to you to understand what comes

937
00:39:00,480 --> 00:39:05,920
next ideally well but but it's okay if

938
00:39:03,440 --> 00:39:06,880
you don't understand it too well okay

939
00:39:05,920 --> 00:39:08,440
and I'm going to tell you when do you

940
00:39:06,880 --> 00:39:11,318
have to start understanding very well

941
00:39:08,440 --> 00:39:14,039
again okay for now this this is a pie in

942
00:39:11,318 --> 00:39:16,639
qu is what I'm doing here is making

943
00:39:14,039 --> 00:39:19,239
things a little bit more realistic the

944
00:39:16,639 --> 00:39:21,440
the message will be similar but it's a

945
00:39:19,239 --> 00:39:23,559
little bit more complicated okay and

946
00:39:21,440 --> 00:39:26,480
that's the reason sort of

947
00:39:23,559 --> 00:39:28,279
substantively H um I already told you

948
00:39:26,480 --> 00:39:29,960
what I wanted to tell you

949
00:39:28,280 --> 00:39:31,359
what I'm going to tell you now will give

950
00:39:29,960 --> 00:39:32,760
you a little bit more realism and

951
00:39:31,358 --> 00:39:34,358
therefore will allow you to understand a

952
00:39:32,760 --> 00:39:36,720
little bit

953
00:39:34,358 --> 00:39:39,159
better a technical description of

954
00:39:36,719 --> 00:39:40,358
monetary policy or something like that

955
00:39:39,159 --> 00:39:43,078
so in

956
00:39:40,358 --> 00:39:45,000
practice you know in the economy I just

957
00:39:43,079 --> 00:39:48,240
describe you had sort of households and

958
00:39:45,000 --> 00:39:50,079
firms and the central bank but in

959
00:39:48,239 --> 00:39:52,318
practice there are lot of financial

960
00:39:50,079 --> 00:39:54,680
intermediaries okay and in financial

961
00:39:52,318 --> 00:39:56,358
intermed the most prominent of them for

962
00:39:54,679 --> 00:39:58,519
especially for monetary policy are the

963
00:39:56,358 --> 00:39:59,719
banks and there are certain Banks

964
00:39:58,519 --> 00:40:02,318
actually they're even more important

965
00:39:59,719 --> 00:40:04,598
than others but banks are financially

966
00:40:02,318 --> 00:40:07,519
intim intimidates they take money from

967
00:40:04,599 --> 00:40:09,039
someone or deposit from someone and lend

968
00:40:07,519 --> 00:40:11,920
it to someone else or buy some

969
00:40:09,039 --> 00:40:13,960
instruments okay so so they intermediate

970
00:40:11,920 --> 00:40:16,559
the funds of somebody that wants to save

971
00:40:13,960 --> 00:40:19,119
on in the bank a deposit in a deposit

972
00:40:16,559 --> 00:40:19,920
account or something and they they lend

973
00:40:19,119 --> 00:40:22,200
that

974
00:40:19,920 --> 00:40:28,280
money effectively in the name of the

975
00:40:22,199 --> 00:40:32,000
other person to H someone else okay so

976
00:40:28,280 --> 00:40:35,519
Banks do two things to the model I just

977
00:40:32,000 --> 00:40:36,719
described the first is that they produce

978
00:40:35,519 --> 00:40:38,318
money as

979
00:40:36,719 --> 00:40:40,039
well

980
00:40:38,318 --> 00:40:43,279
okay

981
00:40:40,039 --> 00:40:45,599
because ER money is made of currency

982
00:40:43,280 --> 00:40:48,680
which is is issued by the central bank

983
00:40:45,599 --> 00:40:51,000
but it's also made of a checkable

984
00:40:48,679 --> 00:40:53,519
deposits if you have a a checking

985
00:40:51,000 --> 00:40:56,639
account something you can have a debit

986
00:40:53,519 --> 00:40:59,880
card against or something like that then

987
00:40:56,639 --> 00:41:02,078
then that's money for you okay if you

988
00:40:59,880 --> 00:41:07,079
deposit in a bank in a checking

989
00:41:02,079 --> 00:41:09,280
account that's money okay and so when

990
00:41:07,079 --> 00:41:12,119
Banks the liabilities of banks the

991
00:41:09,280 --> 00:41:13,599
deposits is part of money it's something

992
00:41:12,119 --> 00:41:15,160
you can use for transactions you can

993
00:41:13,599 --> 00:41:17,559
write checks you can use your debit card

994
00:41:15,159 --> 00:41:20,960
and stuff like that okay so that's the

995
00:41:17,559 --> 00:41:22,318
first thing that Banks do okay the other

996
00:41:20,960 --> 00:41:23,920
thing the banks

997
00:41:22,318 --> 00:41:27,400
do

998
00:41:23,920 --> 00:41:29,760
is they themselves have a deposit

999
00:41:27,400 --> 00:41:34,480
account at the Central

1000
00:41:29,760 --> 00:41:37,359
Bank okay so they themselves take part

1001
00:41:34,480 --> 00:41:39,240
of the deposits they take the deposits

1002
00:41:37,358 --> 00:41:41,719
part of the deposit they lend to other

1003
00:41:39,239 --> 00:41:43,959
people another part they buy financial

1004
00:41:41,719 --> 00:41:46,480
instruments Bond and stuff like that in

1005
00:41:43,960 --> 00:41:49,440
this economy would be only bonds and the

1006
00:41:46,480 --> 00:41:53,480
other part smaller part 10% or something

1007
00:41:49,440 --> 00:41:55,960
like that they deposit at the central

1008
00:41:53,480 --> 00:41:58,358
bank that deposit at the central bank is

1009
00:41:55,960 --> 00:42:01,358
called Reserves

1010
00:41:58,358 --> 00:42:04,358
okay so when you he the word reserves of

1011
00:42:01,358 --> 00:42:07,199
the banking sector this is the deposits

1012
00:42:04,358 --> 00:42:10,639
of the banks at the Central

1013
00:42:07,199 --> 00:42:11,960
Bank okay and that's that's also

1014
00:42:10,639 --> 00:42:13,719
liability for the Central Bank the

1015
00:42:11,960 --> 00:42:15,440
central bank is holding that deposit of

1016
00:42:13,719 --> 00:42:17,598
the banks it's not the central bank's

1017
00:42:15,440 --> 00:42:19,599
money it's the it's the bank's money

1018
00:42:17,599 --> 00:42:22,318
okay and they're holding it there it's a

1019
00:42:19,599 --> 00:42:22,318
liability as

1020
00:42:22,480 --> 00:42:27,960
well so now if you look at how the

1021
00:42:25,760 --> 00:42:30,680
balance sheets look

1022
00:42:27,960 --> 00:42:33,679
our central bank now has more things he

1023
00:42:30,679 --> 00:42:35,960
has assets going to be Bonds in this

1024
00:42:33,679 --> 00:42:38,480
economy this only thing you can have but

1025
00:42:35,960 --> 00:42:40,960
now it will have the currency that had

1026
00:42:38,480 --> 00:42:42,920
before and in liabilities but also will

1027
00:42:40,960 --> 00:42:46,720
have the Reserves the deposits of the

1028
00:42:42,920 --> 00:42:46,720
banks themselves

1029
00:42:48,880 --> 00:42:54,680
okay okay and this is called this stuff

1030
00:42:51,800 --> 00:42:56,519
here is called central bank money in

1031
00:42:54,679 --> 00:42:57,799
contrast it is called Central Bank it

1032
00:42:56,519 --> 00:42:59,800
has so many names

1033
00:42:57,800 --> 00:43:01,280
it's called central bank money high

1034
00:42:59,800 --> 00:43:04,599
power

1035
00:43:01,280 --> 00:43:07,440
money some other name have some but but

1036
00:43:04,599 --> 00:43:09,240
but he has several names and what is I I

1037
00:43:07,440 --> 00:43:11,679
like the name central bank money because

1038
00:43:09,239 --> 00:43:13,279
that's in contrast with this kind of

1039
00:43:11,679 --> 00:43:16,000
money it's the money that the banking

1040
00:43:13,280 --> 00:43:18,119
sector produces the checkable deposits

1041
00:43:16,000 --> 00:43:20,599
okay so this is the money produced by

1042
00:43:18,119 --> 00:43:22,920
the central bank and then the and then

1043
00:43:20,599 --> 00:43:25,800
through deposits the financial system

1044
00:43:22,920 --> 00:43:28,880
the banks themselves produce more

1045
00:43:25,800 --> 00:43:32,240
money so The Total Money in the system

1046
00:43:28,880 --> 00:43:35,318
is much more than the central bank money

1047
00:43:32,239 --> 00:43:39,199
because deposits is a big thing you

1048
00:43:35,318 --> 00:43:43,119
know this is much larger than that in

1049
00:43:39,199 --> 00:43:46,159
practice okay good how does this change

1050
00:43:43,119 --> 00:43:47,400
our mold not really much and so so again

1051
00:43:46,159 --> 00:43:50,000
that's the reason I don't care too much

1052
00:43:47,400 --> 00:43:53,119
if you understand these last two slides

1053
00:43:50,000 --> 00:43:56,559
so let me rederive what we

1054
00:43:53,119 --> 00:43:59,599
have with this approach with with this

1055
00:43:56,559 --> 00:44:01,839
this uh extension so money demand is the

1056
00:43:59,599 --> 00:44:03,079
same as it used to be what happens is

1057
00:44:01,838 --> 00:44:04,719
you're going to demand it in the form of

1058
00:44:03,079 --> 00:44:06,119
currency or checking accounts or

1059
00:44:04,719 --> 00:44:09,799
something like that but but the total

1060
00:44:06,119 --> 00:44:15,240
money demand is exactly as it used to

1061
00:44:09,800 --> 00:44:16,920
be Banks typically hold a share of a and

1062
00:44:15,239 --> 00:44:18,919
assume for now that there's no currency

1063
00:44:16,920 --> 00:44:20,440
so everything is check is deposit

1064
00:44:18,920 --> 00:44:23,800
otherwise you get a more complicated

1065
00:44:20,440 --> 00:44:26,200
formula okay so no one holds cash which

1066
00:44:23,800 --> 00:44:28,318
probably quite realistic nowadays you so

1067
00:44:26,199 --> 00:44:30,439
everyone has a checking account and

1068
00:44:28,318 --> 00:44:33,239
that's it

1069
00:44:30,440 --> 00:44:36,599
okay

1070
00:44:33,239 --> 00:44:40,558
so the banks

1071
00:44:36,599 --> 00:44:42,599
typically hold for regulatory reasons a

1072
00:44:40,559 --> 00:44:45,599
share of their Deposit they have a

1073
00:44:42,599 --> 00:44:48,039
minimum for regulatory reasons a minimum

1074
00:44:45,599 --> 00:44:50,400
share of the deposit they have that they

1075
00:44:48,039 --> 00:44:52,239
need to hold in the form of reserves

1076
00:44:50,400 --> 00:44:55,960
okay and I'm going to call that a fixed

1077
00:44:52,239 --> 00:44:58,879
fraction Theta so if all the money is

1078
00:44:55,960 --> 00:45:01,960
held in the form of the deposits then

1079
00:44:58,880 --> 00:45:05,160
Theta which is a number like 0.1 say

1080
00:45:01,960 --> 00:45:08,760
times the deposits which is money demand

1081
00:45:05,159 --> 00:45:10,639
is equal to the reserves at the is equal

1082
00:45:08,760 --> 00:45:11,520
to the central the demand for central

1083
00:45:10,639 --> 00:45:13,679
bank

1084
00:45:11,519 --> 00:45:16,119
money this is the demand for central

1085
00:45:13,679 --> 00:45:17,960
bank money because is this are the N

1086
00:45:16,119 --> 00:45:20,760
these are the reserves that the banks

1087
00:45:17,960 --> 00:45:22,280
want to have at the central bank so the

1088
00:45:20,760 --> 00:45:24,760
demand they they want to have this

1089
00:45:22,280 --> 00:45:28,480
amount of deposits at the central bank

1090
00:45:24,760 --> 00:45:30,319
this what we call HD it's Theta time m

1091
00:45:28,480 --> 00:45:31,960
and so now rather than M what the

1092
00:45:30,318 --> 00:45:34,039
Central Bank controls really because

1093
00:45:31,960 --> 00:45:36,760
it's the only thing can really control

1094
00:45:34,039 --> 00:45:39,558
is the money that it issues issues which

1095
00:45:36,760 --> 00:45:42,319
is the central bank money so R supplying

1096
00:45:39,559 --> 00:45:43,920
M which used to be currency now m is a

1097
00:45:42,318 --> 00:45:46,159
bigger thing because has deposits and

1098
00:45:43,920 --> 00:45:48,240
all sort of stuff but the central bank

1099
00:45:46,159 --> 00:45:50,480
is the one that controls how much high

1100
00:45:48,239 --> 00:45:53,639
power money how much central bank money

1101
00:45:50,480 --> 00:45:57,559
it issues and we're going to call that

1102
00:45:53,639 --> 00:45:59,639
H okay so if we go back to my balance

1103
00:45:57,559 --> 00:46:01,160
sheet here the Central Bank cannot

1104
00:45:59,639 --> 00:46:03,039
control total money because it cannot

1105
00:46:01,159 --> 00:46:06,399
control the amount of checkable deposits

1106
00:46:03,039 --> 00:46:08,639
in the economy but it can control this

1107
00:46:06,400 --> 00:46:10,920
money here and since we have no currency

1108
00:46:08,639 --> 00:46:14,279
my example it really can control how

1109
00:46:10,920 --> 00:46:16,039
much supply of reserves it can do okay

1110
00:46:14,280 --> 00:46:17,400
and so now we have a demand for Reserve

1111
00:46:16,039 --> 00:46:20,199
which is just proportional to money

1112
00:46:17,400 --> 00:46:22,960
demand equal to some fixed amount H

1113
00:46:20,199 --> 00:46:24,719
which is the supply of high power money

1114
00:46:22,960 --> 00:46:27,318
by the central bank and then the

1115
00:46:24,719 --> 00:46:28,919
equilibrium looks exactly

1116
00:46:27,318 --> 00:46:32,318
like before it's going to be some

1117
00:46:28,920 --> 00:46:36,119
remember before we have m equal to

1118
00:46:32,318 --> 00:46:39,800
Dollar y i now we're saying it's not M

1119
00:46:36,119 --> 00:46:43,000
it's Theta times M really no because

1120
00:46:39,800 --> 00:46:47,200
it's a fraction only of Total Money okay

1121
00:46:43,000 --> 00:46:48,760
has to be equal to a money demand it's

1122
00:46:47,199 --> 00:46:50,279
not Total Money demand it's the money

1123
00:46:48,760 --> 00:46:52,640
demand that ends up being demand for

1124
00:46:50,280 --> 00:46:55,599
central bank money because Total Money

1125
00:46:52,639 --> 00:46:58,039
demand is the checkable checking

1126
00:46:55,599 --> 00:47:00,440
account that leads to a demand for

1127
00:46:58,039 --> 00:47:03,000
central bank money by the Banks which is

1128
00:47:00,440 --> 00:47:04,358
Theta times those deposits it's not the

1129
00:47:03,000 --> 00:47:05,838
full Deposit they don't Deposit they

1130
00:47:04,358 --> 00:47:07,480
don't take all the deposit and deposit

1131
00:47:05,838 --> 00:47:09,279
at Central Bank they say only 10% of

1132
00:47:07,480 --> 00:47:12,760
those deposit will keep them at the

1133
00:47:09,280 --> 00:47:15,720
central bank so $100 in deposit if 30 is

1134
00:47:12,760 --> 00:47:17,640
point1 $100 in deposit leads to a demand

1135
00:47:15,719 --> 00:47:20,439
for reserves that mean for deposits by

1136
00:47:17,639 --> 00:47:23,838
the bank and the Central Bank of

1137
00:47:20,440 --> 00:47:26,280
$10 okay and that is the thing that the

1138
00:47:23,838 --> 00:47:28,838
central bank can control very well it's

1139
00:47:26,280 --> 00:47:31,280
a m the is the demand that comes to me

1140
00:47:28,838 --> 00:47:34,400
the central bank is $10 and I decide

1141
00:47:31,280 --> 00:47:35,720
whether we do $10 or not you we can do

1142
00:47:34,400 --> 00:47:38,680
five and then we're going to have the

1143
00:47:35,719 --> 00:47:41,598
interest rate sort out five to be in

1144
00:47:38,679 --> 00:47:43,598
equilibrium so it's if if if the banking

1145
00:47:41,599 --> 00:47:46,000
sector wanted 10 and I'm only going to

1146
00:47:43,599 --> 00:47:48,680
supply five then something the interest

1147
00:47:46,000 --> 00:47:51,280
rate is going to have to rise so that

1148
00:47:48,679 --> 00:47:54,679
deposits you know decline less demand

1149
00:47:51,280 --> 00:47:57,280
for money and and the and the final

1150
00:47:54,679 --> 00:47:59,118
demand that gets to me is five not 10

1151
00:47:57,280 --> 00:48:01,119
but the mechanism is exactly the same I

1152
00:47:59,119 --> 00:48:03,240
know this this can be a little confusing

1153
00:48:01,119 --> 00:48:06,160
but the mechanism exactly the same it's

1154
00:48:03,239 --> 00:48:09,399
just this just illustrates it makes I

1155
00:48:06,159 --> 00:48:09,399
mean this this is important

1156
00:48:09,800 --> 00:48:14,680
because it's institutionally important

1157
00:48:12,440 --> 00:48:16,200
more than conceptually important because

1158
00:48:14,679 --> 00:48:17,440
this is the market where really the

1159
00:48:16,199 --> 00:48:21,838
interest rate is

1160
00:48:17,440 --> 00:48:24,000
set okay so this I'm doing next time

1161
00:48:21,838 --> 00:48:25,920
that market the market for reserves

1162
00:48:24,000 --> 00:48:27,280
really because what the banks do is they

1163
00:48:25,920 --> 00:48:29,440
want Reserves

1164
00:48:27,280 --> 00:48:31,280
okay deposit at the central bank that

1165
00:48:29,440 --> 00:48:33,639
market for reserves the interest rate in

1166
00:48:31,280 --> 00:48:36,200
that market for reserves is called the

1167
00:48:33,639 --> 00:48:37,960
federal funds rate and it's called the

1168
00:48:36,199 --> 00:48:40,519
federal funds rate because the Federal

1169
00:48:37,960 --> 00:48:42,440
Reserves controls that rate so when the

1170
00:48:40,519 --> 00:48:44,079
FED when when there is a meeting by the

1171
00:48:42,440 --> 00:48:45,440
fed or a policy announcement that tell

1172
00:48:44,079 --> 00:48:48,760
you that the the FED has increased the

1173
00:48:45,440 --> 00:48:50,159
rate by 50 basis points it means it has

1174
00:48:48,760 --> 00:48:54,400
increased the interest rate in that

1175
00:48:50,159 --> 00:48:56,159
market by 50 basis points okay so the

1176
00:48:54,400 --> 00:48:57,920
interest rate that the Central Bank

1177
00:48:56,159 --> 00:49:01,078
controls corly is called the federal

1178
00:48:57,920 --> 00:49:02,920
funds rate and the federal funds rate is

1179
00:49:01,079 --> 00:49:05,280
that market is market for reserve for

1180
00:49:02,920 --> 00:49:08,280
high power money so all the operations

1181
00:49:05,280 --> 00:49:11,000
happen there they don't participate in

1182
00:49:08,280 --> 00:49:13,040
the deposit Market or anything they

1183
00:49:11,000 --> 00:49:15,000
participate in that market which every

1184
00:49:13,039 --> 00:49:17,639
night is a is a Hu huge number of

1185
00:49:15,000 --> 00:49:19,239
transactions every night because I put

1186
00:49:17,639 --> 00:49:20,798
all the banks together but what happens

1187
00:49:19,239 --> 00:49:22,199
every night is some banks have more

1188
00:49:20,798 --> 00:49:24,318
reserves than they need some other banks

1189
00:49:22,199 --> 00:49:26,358
have less reserves than they need so

1190
00:49:24,318 --> 00:49:28,039
they supply and demand within the

1191
00:49:26,358 --> 00:49:29,558
banking sector for for reserves and

1192
00:49:28,039 --> 00:49:31,920
there's an interest rate that tends to

1193
00:49:29,559 --> 00:49:33,680
equilibrate if too many banks are short

1194
00:49:31,920 --> 00:49:34,880
reserves then there's going to be lots

1195
00:49:33,679 --> 00:49:36,639
of demand for reserve and interest rate

1196
00:49:34,880 --> 00:49:38,920
is going to tend to go up If the Fed

1197
00:49:36,639 --> 00:49:40,838
doesn't want that interest rate to go up

1198
00:49:38,920 --> 00:49:42,920
then what it will do overnight it will

1199
00:49:40,838 --> 00:49:44,759
go there and inject reserves into the

1200
00:49:42,920 --> 00:49:47,519
system high power money so the interest

1201
00:49:44,760 --> 00:49:50,160
rate in that market comes down okay and

1202
00:49:47,519 --> 00:49:51,880
that's the way the FED operates that's

1203
00:49:50,159 --> 00:49:53,920
the way it controls it participates in

1204
00:49:51,880 --> 00:49:57,200
that market controls the amount of high

1205
00:49:53,920 --> 00:50:00,079
power money which regulates the rate in

1206
00:49:57,199 --> 00:50:02,879
the resarch market and here it's only

1207
00:50:00,079 --> 00:50:06,798
you know and then so here you have sort

1208
00:50:02,880 --> 00:50:09,240
of the major Banks participating here

1209
00:50:06,798 --> 00:50:10,759
and and and then this leaks into the

1210
00:50:09,239 --> 00:50:13,479
other interest rates in the economy to

1211
00:50:10,760 --> 00:50:15,760
into deposit rates to to bond rates and

1212
00:50:13,480 --> 00:50:18,679
so on but but the real rate they control

1213
00:50:15,760 --> 00:50:21,040
the rate that they control most directly

1214
00:50:18,679 --> 00:50:22,318
is that rate here okay and that's the

1215
00:50:21,039 --> 00:50:23,440
reason I wanted to give you a little bit

1216
00:50:22,318 --> 00:50:26,239
of

1217
00:50:23,440 --> 00:50:29,039
institutional I mean to add complexity

1218
00:50:26,239 --> 00:50:29,039
so we could get

1219
00:50:29,358 --> 00:50:34,159
to so you could get to this word federal

1220
00:50:32,039 --> 00:50:36,719
funds rate because that's what you're

1221
00:50:34,159 --> 00:50:38,480
going to read in the newspapers the FED

1222
00:50:36,719 --> 00:50:39,798
increase the federal funds Target is

1223
00:50:38,480 --> 00:50:41,159
going to say because they target they

1224
00:50:39,798 --> 00:50:42,719
cannot guarantee it's going to be that

1225
00:50:41,159 --> 00:50:44,318
they target an interest rate and

1226
00:50:42,719 --> 00:50:49,000
typically they give you a range it's a

1227
00:50:44,318 --> 00:50:51,119
very narrow range okay you let me just

1228
00:50:49,000 --> 00:50:55,519
conclude by showing you how that rate

1229
00:50:51,119 --> 00:51:00,119
has looked in the US recently okay and I

1230
00:50:55,519 --> 00:51:02,679
finish here so here here is before covid

1231
00:51:00,119 --> 00:51:04,798
okay H the interest rate the Fed was

1232
00:51:02,679 --> 00:51:06,598
already hik in interest rate it had

1233
00:51:04,798 --> 00:51:08,559
overdone it there so it was beginning to

1234
00:51:06,599 --> 00:51:10,760
lower interest rate and then covid came

1235
00:51:08,559 --> 00:51:13,000
boom and they cut interest rate very

1236
00:51:10,760 --> 00:51:14,160
aggressively the this is the maximum

1237
00:51:13,000 --> 00:51:15,639
they can cut it too and we're going to

1238
00:51:14,159 --> 00:51:18,078
talk about that briefly in the next to

1239
00:51:15,639 --> 00:51:20,159
zero you cannot go below zero you cannot

1240
00:51:18,079 --> 00:51:22,079
pay negative interest rate because then

1241
00:51:20,159 --> 00:51:24,279
I don't demand money I don't demand

1242
00:51:22,079 --> 00:51:26,318
bonds why should I hold a bond that pays

1243
00:51:24,280 --> 00:51:28,280
me a negative interest rate when cash

1244
00:51:26,318 --> 00:51:30,318
pays zero always zero I can always keep

1245
00:51:28,280 --> 00:51:31,640
it under the mattress and and and I

1246
00:51:30,318 --> 00:51:33,798
don't pay in negative so the interest

1247
00:51:31,639 --> 00:51:35,199
rate the lowest can be zero and you see

1248
00:51:33,798 --> 00:51:36,960
that they they did the maximum they

1249
00:51:35,199 --> 00:51:39,039
could in terms of cutting interest rate

1250
00:51:36,960 --> 00:51:40,559
they went to zero effectively zero and

1251
00:51:39,039 --> 00:51:42,000
now they have been trying to catch up

1252
00:51:40,559 --> 00:51:44,000
because inflation is very high and so

1253
00:51:42,000 --> 00:51:46,039
they're trying to to hike interest rate

1254
00:51:44,000 --> 00:51:48,039
and you see how what they're doing okay

1255
00:51:46,039 --> 00:51:50,119
well all those interventions happen in

1256
00:51:48,039 --> 00:51:52,480
the reserve Market that's what where

1257
00:51:50,119 --> 00:51:56,039
this is that's the rate is in that

1258
00:51:52,480 --> 00:51:59,679
market over okay okay so I think we're

1259
00:51:56,039 --> 00:52:02,960
meeting on Tuesday next week uh I think

1260
00:51:59,679 --> 00:52:02,960
that's the plan